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Internet companies shop 'til they drop

by John Geralds in Silicon Valley

Using the sky high valuations of their shares, Internet companies are on major acquisition hunts, snapping up other companies almost all of which are Web related.

According to data from Thomson Financial Securities Data which tracks mergers and acquisitions, US Internet firms made $12.29 billion worth of aqcuisitions last quarter - greater than the $8.61 billion total last year. In the international market, 156 companies announced acquisitions worth $4.5 billion in the first quarter, closing in on last year's total of $6.8 billion.

"We expect this trend to continue throughout the year and expect to see both the US and the international market exceed last year," said Richard Peterson, an analyst at Thomson.

Within the past few months, the Internet has witnessed a snowballing trend toward consolidation. At Home announced it would acquire Excite for $6.7 billion in stock, which essentially adds a content and commerce interface to its broadband network. And among the biggest deals last quarter was Yahoo's agreement to buy Geocities for $4.66 billion in stock.

Analysts believe Internet firms are scrambling for assets that can fill holes in their strategies. "The trend we are seeing is one of high multiple companies buying other high multiple companies," said Thomas Burnett, director of Merger Insight, a research firm in New York. Almost all the deals were for stock.

Burnett said that although the acquirers so far have gone after their own kind, this is likely to change, and soon. "The idea would be to use your high multiple stock to buy a real company," he said. He speculated that an Internet Service Provider like America Online would find it increasingly attractive to buy or team up with non Internet media firms such as CBS. "AOL has to leverage their 16 million customers," he said. Other targets for Internet companies might be savings institutions or banks, which could provide online financial services, he added.

The wooers are the usual suspects ranging from media companies such as Sony and CBS to telecommunications companies including AT&T, MCI Worldcom, Ericsson and BT. And there is always Microsoft which is consistently rumored to be talking to Web companies about potential acquisitions or longterm investments.

Swedish telecom equipment maker Ericsson, for example, recently spent close to $500 million on Internet buys. Most recently, the company bought US Internet router company Torrnet Networking Technologies for $450 million in cash to boost its Internet offerings.

Ericsson said it had also acquired Touchwave, a Silicon Valley based provider of business IP telephony solutions for $46 million in cash. Meanwhile, German rival Siemens purchased Argon Networks for about $240 million and Castle Networks for about $300 million in cash to bolster its new "converged networks" team, Unisphere Solutions. And unlike Finland's Nokia, which last year acquired Ipsilon, Alcatel has purchased both technology and brand name assets in the US in the form of switch manufacturer Xylan for $2 billion in cash and stock.

"These European carriers have decided that to be successful, they have to get into data. And they have lots of cash to spend," said Todd Dagres, a venture capitalist with Battery Ventures.

"What you've seen is, the billion-dollar deals have all been done by Internet companies themselves," said David Simons, managing director of Digital Video Investments. "These companies have this highly value script which enables them to buy these Internet companies. The acquirers have enough stock of great enough value that they can buy these things without having a dilutive effect on their earnings."

In effect, the stock phenomenon among Web companies ranging from popular portals like Yahoo to ecommerce firms such as Amazon.com has given these companies the ability to do deals that their cash flow would not allow. Amazon, for instance, which has acquired Junglee and Planet All recently, is still in the red. The firm reported a loss of $17.8 million or $0.14 per share in its latest quarterly earnings report.

By comparison, traditional media companies such as NBC and Disney have made significant investments in the online space, but those deals have been relatively small compared to the multibillion dollar deals being wielded by the Net players.

"Major media companies haven't gone out spending billions," Simons added. "They have been doing strategic deals that do not deal with that much stock. The reality is the major media companies, in terms of what Wall street demands of them, cannot afford to do these deals. Wall Street values them and measures them on a totally different scale than these Internet companies.

Although the valuations for many Internet companies seem to be out of this world, investors are banking on what could be unheard of power and worth in the media space if computers and televisions continue to converge, for example. Some analysts said that although the investments in these firms is great, the cost and time involved for the companies to develop the infrastructure makes acquiring a Web property seem less daunting.

"They're also becoming aware that the Internet is likely to become the dominant form of electronic media and there's little choice but to jump in at some point," said Andrew Bartell, an analyst at the Giga Information Group. "It's almost like this is the ship they need to get on, otherwise the best they can hope for is a lifeboat on their existing business."

Yahoo cofounder Jerry Yang said that the Internet company's top priority is continued growth. "We have to grow," Yang said. "That is probably the only thing that matters at the end of the day. No matter what the stock prices are, no matter what market capitalizations are, we really have to grow. So when we look at acquisitions, we look at it as a way to grow," Yang said.

Yahoo's acquisitions fit in nicely with the recent acquisitions and merger announcements between At Home Network and Excite, America Online and Netscape and NBC and Snap.com which followed on the heels of Disney's purchase of Infoseek. It also furthers the idea that consolidation on the Web is inevitable.

In fact with Yahoo trading at $367.75 per share, giving it a market capitalization of $32.6 billion, the company could conceivably continue to pursue fairly large deals, particularly now that the sceptical Federal Reserve chief Alan Greenspan has blessed the future of the Web.

The Fed chairman, in remarks before the Senate Budget Committee, stated that some Internet companies are bound to become major players in the economy as "a significant part of the distribution of goods and services" moves to an Internet based system. He also said that "some Internet companies very well may justify even higher prices."

"Whether it is deserved or not, a large market capitalization is now a major competitive advantage because it significantly lowers the cost of capital for the acquiring company," said Henry Blodgett, Internet analyst with Merrill Lynch.

"Acquisitions will be a strong component to driving growth and taking market share," said Tim Koogle, Yahoo's chief executive. "We're going to be pretty prudent, but we are going to be opportunistic."

What's been good for Yahoo has been great for the Internet sector. Public companies like InterVU and Real Networks have seen their stocks rise. Yet, Keith Benjamin, an analyst with Banc Boston Robertson Stephens, expressed concern over the valuations of some of the recent Internet initial public offerings (IPO) and what he sees as Internet investors' current lack of discernment.

"We are distressed by the differentiations among Internet stocks by investors," Benjamin said. "Every Internet related IPO seems to go up with little regard for the company behind the stock."

As a Web property AOL's muscle is rivaled only by Yahoo's. With its acquisitions of Netscape Communications and Mirabilis, (the developer of the instant-messaging service ICQ), AOL is adding to its Internet portfolio and its list of content acquisitions also continues to grow. This combination may explain why Benjamin recently said, "If we had to own just one Internet stock, it would continue to be AOL."

Since the beginning of the year, Compaq has committed more than $500 million cash to Internet acquisitions: $200 million for Shopping.com, a second tier online retailer; and a reported $300 million for privately held Zip2, which provides local portal and ecommerce systems for newspapers.

Although Compaq paid cash, most major acquisitions of Internet companies, analysts said, especially public ones, have been by other Internet companies and paid for with their stocks. Because of the risk inherent in stock, acquisitions paid with it usually are at a premium to what would be the cash price.

What lies ahead on the acquisition highway? More of the same and probably some unexpected combinations. However, there will likely be no clear winner in the race to be the biggest, baddest and broadest on the Web. Rather, as the buying spree continues, a handful of major players will be left to define the space and fight over all of those advertising and ecommerce dollars.